The publication of JP Morgan’s seminal report “Impact Investments: An emerging asset class” (29 Nov 2010) is the watershed proclamation that Impact Investment is going mainstream. In the wake of the 2007/8 financial crisis we should be encouraged when Nick O’Donohoe, Global Head of Research for JP Morgan, tells us “From our chief executive officer down, there’s a strong sense at JP Morgan that banking institutions have the ability to make a positive contribution to society” – So wherein lies the rub?
JP Morgan has drawn three primary conclusions from its research:
- Impact Investment is being accepted by investors as an emerging and separate asset class.
- The potential exists to attract enormous sums of investment capital into the Impact Investment market “approaching a trillion dollars… is just part of the investing potential”.
- Evidence from the first substantive survey of impact investors’ projected financial returns reveals that they anticipate commercial or close to commercial returns.
JP Morgan will no doubt be able to capitalise on this first-mover advantage which will be good for increasing its market share within a beleaguered sector, good for JP Morgan shareholders and surely good also for increasing the socially beneficial outcomes of big finance.
And so it is – but does the hype mean that social impact will not only receive more airtime but be maximised? Unlikely, unless there is more substantive reform of finance.
To maximise the social impact of investment, and more pertinently to prioritise it, would require system change across the world of big finance – this may or may not be JP Morgan’s intention. Do the incumbent helmsmen have the nous and foresight to do it? After all, it is the bank which carries the name of legendary banker J.P. Morgan who in 1907, witnessing systemic failure of the financial system, single handedly orchestrated a private sector bailout which earned him demigod status as saviour of the banking system. These are big boots to fill at a time when coincidentally JP Morgan has decided to move its European HQ into the building formerly occupied by failed rival Lehman Brothers – hopefully it is not an omen, presumably the bad spirits of hubris have been exorcised from the building.
JP Morgan has ostensibly chosen to go in a laudable direction, however one must analyse whether they have set their course by asking the right questions. If not, they risk getting the fundamentals wrong and presiding over an asset bubble.
A ‘right’ question to ask is how can we attract greater sums of capital for the creation of social benefit, and do we need a new rule set to do it? A ‘wrong’ question to ask is how do we harness the zeitgeist to develop new financial innovations and business lines which will maximise profits with the least internal restructuring?
My concern is that private sector organisations, and particularly the juggernauts of the financial sector, typically tend towards conglomeration and seek to crowd out competition in order to secure market share in a winner-takes-all-model. Innovation and efficiencies may be generated along the way, but at scale these organisations tend towards self-serving behemoths and are hard-wired to a predatorial DNA. If mainstream Impact Investment products are to work for society, and not just for investors, then there needs to be a metamorphosis away from models spawned by the Washington Consensus. It is self evident that self-interest will not reduce inequality and cannot deliver socio-economic cohesion.
Antony Bugg-Levine, Managing Director at the Rockefeller Foundation, tells us that “defining impact investing as an asset class encourages the emergence of a community organized around impact investing”. Fair point, but what will this community look like and what shape will it take?
- Successful models will be flexible and adaptable to be able to better respond to a broader economics paradigm of increased uncertainty and unpredictability; complexity will need to be accepted as par for the course.
- We will see the Third Sector take on many attributes of the Financial Sector and vice versa, the lines between the two will blur as they both embrace principles of the other which have seemed hitherto counter-intuitive.
- Universal acceptance that imperfect and asymmetric information exists within markets and that it has a bearing on real risk.
- That strategic and positive risk taking is essential in the creation of long-term value, which will be prioritised over short-term zero-sum gains.
- Acknowledgment that investment decisions are often irrational and that the efficient market hypothesis has been debunked.
- And most controversially, that the real worth of money is relative and subjective, and that value is added when there is a consensus view that something has become worth more to people, and not just because the asset price has gone up.
Is this what JP Morgan is doing? No. The report suggests that they have approached the issue from a traditional mono-line perspective, by adopting a “methodology for measuring the invested capital requirement and potential profit opportunity in selected businesses and sub-sectors within housing, water, health, education and financial services targeting BoP [Base of the Pyramid] populations”
For example, in assessing the demand within affordable housing they exclude people earning less than $1 a day and say that “We must acknowledge that there is a portion of the population at the lowest income level that remain reliant largely on aid”. Surely the greatest social impact could be achieved if this area of need is focused on, and not excluded? This is obviously an unrealistic priority for a private sector conglomerate and we shouldn’t be too critical of what JP Morgan has achieved given its constraints.
In fairness to JP Morgan, they do acknowledge in the footnotes that there is a requirement for building capacity in order for people to escape poverty and deprivation through self-sustaining market-based systems, even at the very base of the economic pyramid, and that in future they would like to address the lowest income brackets – but for now will focus on proven business models.
Understandably, JP Morgan’s analytical framework suggests objectives focused on maximising profit and not maximising social impact.
In my opinion, Impact Investment will be most effective within a partnership framework embracing public, private and philanthropic actors; which treats financial returns as a cost of capital and passes reduced transaction costs and lower fees onto deserving consumers through more affordable, flexible and better structured financial services and products. This foray into Impact Investments will be successful for JP Morgan but more importantly, thanks to the JP Morgan plough, the field is now ready for planting by a more diverse range of new and previously fringe players.
It may be a long way off to imagine a confederation of ethical, alternative and social finance institutions which has the scale, geographic reach and range of sophisticated products of big finance – but that doesn’t mean it won’t happen. There are an ever increasing number of innovative banking services, investment products and financial instruments being developed by non-mainstream organisations. At some point the mainstream institutions will inevitably conclude that this is a threat to their established market share.
The cartel-like model of big finance, demonstrated by the universal reluctance of banks to agree global remuneration practices consistent with other industries, may yet be destabilised. It is unlikely that this will happen through more aggressive regulation and government intervention, but rather in response to leftfield competition, such as a credible and viable alternative to commercial big finance.
Imagine for moment a scenario in which a confederation of ethical, alternative and social finance entities organise themselves with the scale, geographic reach and range of sophisticated products of big finance, with a combined balance sheet of similar magnitude to some of the big banks. Imagine that this confederation has a mandate to focus on blended returns, prioritising social outcomes and treating investment returns as a cost of capital. Imagine that it operates according to a non-profit model and therefore can offer capital on softer terms with reduced finance charges, fees and transaction costs, and pass these savings on to eligible customers. Imagine what will happen when customers are confronted with a cheaper and more attractive alternative to mainstream finance.
Is it naive to imagine in this theoretical scenario that the consequence of competition will force commercial finance institutions to lower the prices of financial services and products in order to remain competitive? In market segments where there is competition from sophisticated and innovative non-profits, they would end up chasing a downward price curve thereby reducing the scope for exorbitant profits and, shortly after that, the scope for excessive remuneration.
Oops, have I let the cat out of the bag? Finance has suddenly got much more interesting.